Behind Korea's Plunge

By Alice H. Amsden and Yoon-Dae Euh, The New York Times,
27 November 1997

[S] outh Korea has competed brilliantly in basic industries like steel
and semiconductors, and has moved ahead quickly in high technology. Yet
financial markets are teetering, the Korean currency has nose-dived,
and International Monetary Fund officials are considering South Korea's
request for a $20 billion bailout loan.

Economic experts have blamed too much Government regulation and
oversight for South Korea's problems. But it isn't that simple. When
the Government controlled the financial markets in the 1970's and
1980's, Korea's growth was stupendous. Not until the early 1990's,
when financial markets were deregulated, did the economy sink. Indeed,
it was the Government's decision to allow banks and other financial
institutions to borrow and lend without interference that created the
current crisis.

In the 1970's, the Government decided how many financial institutions
could exist and what they could do. But in the 1980's the world's
leading financial institutions expanded internationally, and, in order
to compete, South Korea had to loosen its rigid controls. The
Government allowed banks to have more say on interest rates and to have
overseas operations.

But the Government went too far. In 1995, South Korea made a Faustian
bargain with the United States. In exchange for membership in the
prestigious Organization for Economic Cooperation and Development, it
agreed to loosen almost all controls on financial institutions, both
international and domestic.

Foreign banks were no longer barred from buying and selling large
amounts of foreign currency; that enabled them to speculate against the
Korean currency, the won. The result? When Southeast Asian currencies
fell this year, the won also weakened, but speculation made the
currency's slide even more dramatic.

South Korea also didn't monitor its own banks as they ventured farther
afield. Merchant banks, which can engage in most financial
transactions, lent recklessly. They took out loans from international
institutions, but gave out loans to risky ventures, like finance
companies in Southeast Asia. When many of these businesses went bust
earlier this year, South Korea's merchant banks were stuck with bad
loans totaling $3 billion.

The Government's looser restrictions on manufacturing companies were
also harmful. Companies became free to take out loans from foreign
banks -- and many of them overindulged. They borrowed lots of money,
yet they didn't turn these loans into sensible long-term investments.

The companies defaulted on loans, partly because the won had weakened.
These bad loans helped create a crisis for South Korea's entire
commercial banking system. Not only were companies unable to pay back
their foreign loans, but they couldn't pay back their old loans to
South Korea's commercial banks, either.

When word got around that some financial institutions were failing,
there was an old-fashioned run on the banks. Businesses and individuals
withdrew their money, and banks were forced to call in their loans to
companies that were highly leveraged but profitable. These companies
were innocent victims; because of the panic, they went bankrupt.
Hoping to avoid future crises, international economists and regulators
are calling for an overhaul of South Korea's manufacturing and
financial sectors. Certainly, the Government must reform its banking
system and revamp some of its industries.

But the crisis also shows that the United States, acting out of
self-interest, was wrong to push the South Korean Government to open up
its financial system so quickly. The Government and its financial
institutions didn't have time to develop adequate ways to control and
monitor this brave new world.

As the international experts set the terms for South Korea's bailout,
they would do well to remember this mistake. Alice H. Amsden is
professor of political economy at the Massachusetts Institute of
Technology. Yoon-Dae Euh, a professor of international finance at
Korea University, is a former member of the South Korea's Monetary
Board.